Smart Money Analysis-Betting on a CF takeover

* Arb spread favors Agrium-CF deal over CF-Terra deal (For other stories in this series on hedge fund activity in the second quarter, click on [ID:nN01502629])

By Euan Rocha

TORONTO, Sept 2 (Reuters) – Major hedge funds have started to build positions in U.S. fertilizer maker CF Industries Holdings Inc (CF.N), betting it will be bought by larger Canadian rival Agrium Inc (AGU.TO) even as CF continues to spurn the takeover bid.

Agrium has twice-sweetened its offer and last bid $40 in cash and one common share for each CF share, implying a deal value of about $4.19 billion, or $86.44 per share.

CF maintains that Agrium is undervaluing the company and is trying to derail CF’s own bid for Terra Industries Inc (TRA.N), another fertilizer producer.

“While CF management is determined to pursue the Terra deal, we suspect that CF shareholders are reluctant to pay a premium for Terra while Agrium is offering them a premium,” said Broadpoint AmTech analyst Edlain Rodriguez.

An analysis by Thomson Reuters of U.S. regulatory filings show growing interest from hedge funds in CF, the third-largest producer and distributor of nitrogen and phosphate fertilizer products in North America.

The funds now collectively own more than 11 percent of CF’s outstanding shares and are among its 20 largest investors.

Hedge funds made similar bets on drugmakers Wyeth (WYE.N) and Schering Plough (SGP.N) earlier this year, following buyout offers, and both deals are now well on their way to closing.

None of these funds cite Terra Industries or Agrium among their top holdings in the second quarter.

Representatives of the various funds either declined to comment, or were not reachable for comment.

(Click on [ID:nN01234966] for details on top plays by hedge funds in the second quarter)

ARBITRAGE SPREAD

Agrium, a Calgary, Alberta-based fertilizer maker and agricultural products retailer, launched its first bid to take over Deerfield, Illinois-based CF Industries in February.

Since then, CF shares have soared more than 60 percent to trade at around $80 a share, roughly 10 times expected 2009 earnings.

Arbitrage spreads indicate far greater investor confidence in the success of an Agrium-CF deal, over a CF-Terra deal.

The arb spread, a measure of the difference between a company’s share price and the price a buyer is offering, is 8 percent on the Agrium-CF deal, while the spread on the CF-Terra deal is more than 22 percent.

A wider spread typically indicates investor skepticism that a deal will close.

“It does seem to be tilted in favor of the Agrium-CF deal at present,” said Morningstar analyst Ben Johnson.

“Sentiment has been swaying back and forth. But the expansion in the spread on CF-Terra and the contraction of the spread on Agrium-CF has become more apparent now than at any other time I can recall in the recent memory.”

Nonetheless, CF is still looking for a better price and arbitrage investors have indicated they are hoping for a $5 to $10 increase in Agrium’s bid.

Broadpoint’s Rodriguez contends that CF is trading at a premium to its fair value, which he pegs at $75 a share.